Retiring on the cheap

Couple wants to maximize retirement income while keeping taxes to a minimum

Hey there, time traveller!This article was published 1/11/2013 (1384 days ago), so information in it may no longer be current.

Jim and Janet know they will have to stretch their dollars when Jim retires soon.

It's not a new experience for the couple in their early 60s. They've been making do on one salary since Janet was downsized from a management job a few years ago.

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With no work pension, she had been earning no income at all until she began collecting CPP a year ago, to the tune of about $430 a month.

"Part of the plan is, since Janet doesn't have a pension, to do RRSPs for her and stick with my pension for me," says Jim, who earns about $58,000 annually.

Janet has an RRSP of about $120,000, which she is reluctant to touch until Jim retires.

Jim has been setting aside additional savings in a TFSA, accumulating about $26,000.

All told, the couple have almost $170,000 for retirement, and their home, worth about $187,000, is mortgage-free.

They do have some debt, having recently purchased an RV on a line of credit, and now owe about $27,000.

"We've taken on more debt than we've had for quite a while, but it's (the RV) part of our plan for our retirement," Janet says. "We want to park it somewhere so the kids and grandkids can come out and enjoy each other's company."

Although they believe they will have enough income to cover their current expenses -- about $2,400 a month -- once Jim retires, the couple wants advice so they can make the most of their money.

"We want to know if we're on the right track or if we're going to eat cat food," she says.

Certified financial planner Doug Nelson says Janet and Jim should be able to afford their modest retirement with few financial snafus as long as they plan to draw equal incomes once Jim retires. By evenly splitting their sources of income as much as possible, they will collectively pay less in taxes than they would otherwise and put more money in their wallets.

"The first step in this process relates to their CPP income amounts," says the adviser with Nelson Financial Consultants in Winnipeg.

CPP income can be split evenly, lowering Jim's income and reducing the taxes he pays without increasing Janet's taxes. To do this, Jim and Janet need to contact Service Canada to request their CPP payments are split equally.

Once Jim retires, the next step is to split his work pension income on their tax return, allowing him to share up to 50 per cent of his pension with Janet.

"The result of the steps will be two incomes of approximately $19,000 each," says Nelson, author of the personal finance book Master Your Retirement.

This strategy will keep their average income tax rate at about 10 per cent, resulting in combined after-tax cash flow of about $2,850 per month.

It's also a guaranteed income stream that doesn't include withdrawals from Jane's RRSP or Jim's TFSA, money that can be used at their discretion for additional expenses such as vacations.

When they do need additional cash, they should withdraw from Jane's RRSP first.

Because RRSP withdrawals are fully taxable, the money needs to be withdrawn strategically so they are not increasing their taxes substantially.

"The most significant boundary to be aware of is the top of the current tax bracket of $31,000 annually," Nelson says. As long as they keep both of their incomes under that threshold before age 65, they will not bump their marginal tax rate from the lower bracket of 25.8 per cent to 27.75 per cent.

As a result, Janet could withdraw $12,000 a year from her RRSP, paying at the lowest marginal rate.

Once they turn 65, if they choose, Janet and Jim could each withdraw that amount because they'd be able to split Janet's RRSP income.

But the couple will also start collecting OAS at that juncture and will inevitably pay a little more tax. On the upside, they will also earn significantly more guaranteed income, about $3,900 a month.

Tax-wise, the couple will want to keep their individual net annual incomes below $34,562 to qualify for the age-amount credit.

"This amount is indexed with inflation, so by the time Jim and Janet reach age 65, the threshold could be approximately $37,000 each."

The credit represents as much as $2,800 a year in tax savings, which is significant, Nelson says.

"Over 25 years of retirement, this could be a benefit of $70,000."

At age 65, their individual guaranteed sources of income will be about $23,000 net a year. Even when these incomes are indexed for inflation, they could withdraw $8,000 each annually from Janet's RRSP and still easily qualify for the age amount.

Nelson says Jim and Janet don't need to draw on her RRSP savings early in retirement unless they need the income. If they decide to leave the RRSP untouched, Janet's account may grow to about $180,000, based on a four per cent annual return by the time she has to convert it to an RRIF and make mandatory withdrawals at age 72.

Starting at a mandatory, annual rate of 7.38 per cent of assets in the account, she would have to withdraw a minimum of about $13,000.

Because they can split this income, too, it would not push Janet or Jim's individual net incomes to the point where they would no longer qualify for the age amount.

"This is good, but they may not need this additional income as much, at that stage in life," Nelson says.

As a result, they may want to use her RRSP income sooner than later.

Even though Jim and Janet are right on track, they do have a few other issues to consider. For one, Jim has to choose between a two-thirds and 100 per cent survivor's work pension benefit for Janet. Nelson says while selecting the 100 per cent option will slightly reduce the monthly pension payment he will receive while alive, it also ensures Janet has long-term financial security if he dies before her. Furthermore, it provides them more flexibility to draw on her RRSPs in early retirement should they need money, because she won't need it later in life if Jim predeceases her.

As for their TFSAs, these should be their accounts of last resort.

"In my view, this is their 'sleep at night' money."

It may be tempting to use these savings to eliminate the $27,000 debt, but they will likely have enough regular income to afford monthly payments and eliminate the debt in about five years.

Overall, Jim and Janet are in good shape, but they need to pay attention to their spending going forward. Rising costs are the biggest threat to their retirement, and they may find hitting the road is more costly than anticipated. As well, they may face increased medical expenses as they age.

"The key to the success of this plan is Jim and Janet's projections for expenses," Nelson says.

Fortunately, if they do find they've lowballed their costs, at least they know a safety net of savings has got their back.

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